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[Prefer to listen? You can find a podcast version of this article here: E3: Why Compound Interest Is Your Bestie]

If there’s one concept in personal finance that truly changes the game, it’s compound interest. It’s not flashy, it’s not complicated, and it definitely doesn’t get enough credit, but it’s the reason long-term investing works and the reason so many people have been able to turn small beginnings into meaningful wealth.

Albert Einstein allegedly called compound interest “the eighth wonder of the world” and claimed that “he who understands it, earns it, and he who doesn’t, pays it.” Albert seems like a dramatic guy, but once you see how powerful it is, you start to understand why he said it. The truth is simple:

If you understand compound interest, it can help you build wealth.

If you ignore it… it can quietly work against you in the form or inflation or debt.

Let’s break it all down.

What Is Compound Interest?

At its core, compound interest is interest earned on top of the interest you already earned. Your money starts making more money, and then that money starts making money too. It’s like your dollars have their own little side hustles.

Here’s the simplest example:

You invest $1,000 at a 5% annual return.

• After one year, you earn $50. Easy enough.
• In year two, you're not just earning on your original $1,000… you’re earning on the $50 you made last year too.

Your new balance at the end of year 2 then becomes $1,102.50.

That extra couple of dollars doesn’t seem life-changing, but this effect snowballs massively over time. Give it decades, and what looked tiny in year two becomes incredibly meaningful in year 20, 30, or 40.

Take this example: Invest $5,000 at age 25, never add another dollar, earn roughly 7% a year (the long-term average of the stock market), and by age 65 that one-time investment becomes over $74,000.

That growth didn’t come from working harder, it came from time and compounding doing their thing in the background while you lived your life.

Compound Interest in Investing: Not All Interest Is Created Equal

It may sound too good to be true, and for the most part it really is just that great –you’re your success in harnessing its power depends on where you put it. And some places aren’t doing you any favors.

• Traditional savings accounts: Think 0.01% interest, give or take a few basis points. You could leave $1,000 in there for a decade and barely earn enough interest to buy yourself a latte.
• High-yield savings accounts: These usually offer around 3.5–4.5% today. Much better and great for emergency funds or money you need in the near term. Keep in mind that these returns will start to lower if the Federal Reserve continues to drop interest rates.
• Long-term investing in the stock market: Historically, the stock market has returned an average of 7–10% per year after inflation. That’s why investing even small, consistent amounts, is one of the most powerful ways to build lasting wealth.

But just like compounding can build wealth, it can also build debt.

When Compound Interest Works Against You

Let’s talk about credit cards. I think of them as knifes because they can be such a useful tool if you use them correctly, but they can quickly become a source of danger if you aren’t careful.

If you carry a $5,000 balance on a card charging 20% interest and you only make minimum payments, you could easily pay over $10,000 in interest alone.

This is compounding working in reverse. Instead of your money growing, your debt is quietly multiplying, and it's doing so daily. I’m still a huge fan of credit cards, but if you’re aware of the risks you may be less likely to fall into the debt trap.

The bottom line is this - use compounding to grow your wealth, not your debt.

Inflation: The Other Invisible Money Force

Compounding is powerful, but inflation is always lurking in the background. Inflation simply means prices rise over time, which lowers the purchasing power of your money.

If inflation averages 3% a year, the $100 sitting in your checking account is effectively worth only about $97 next year.

So if your money is growing slower than price you’re actually losing money without realizing it.

That’s why investing is so important. In finance, we talk about your real return which is your return after accounting for inflation. For example:

• HYSA earning 5% with 3% inflation → real return ~2%
• Long-term stock market average 8–10% with 3% inflation → real return ~5–7%

That difference becomes massive over decades. When your money grows faster than inflation, you’re not just building wealth, you’re protecting it.

The Big Takeaways

If you can remember these things, then you are Einstein level approved at understanding compound interest:

• Compound interest is your money earning more money, and then earning even more on top of that.
• It’s one of the most powerful tools for building wealth, especially if you start young.
• Not all interest is created equal. Big bank savings? Not great. Investing in a diversified portfolio of equities? That’s where compounding shines.
• Debt compounds too, but in the wrong direction. Be mindful of high-interest balances.
• Inflation never sleeps. Your money needs to grow faster than prices rise. And historically, stocks and diversified index funds have been one of the best ways to achieve that.

If you want to build meaningful, long-term wealth, compounding is the engine that gets you there. The sooner you start, and the more intentionally you use it, the more powerful it becomes.